By Wayne Arnold

Georgina "Gina" Rinehart, Australia's wealthiest person, has apparently seen the future. And it says "Moo."

Rinehart this weekend struck a deal to invest AUD500 million ($436 million) alongside state-owned China National Machinery Industry, or Sinomach, in a 5,000-hectare dairy farm in Queensland to produce and export up to 30,000 metric tons of infant formula to China, as well as boxed milk, most of it produced from 15,000 Holstein cows.

Rinehart, who became Australia's wealthiest person by helping feed China's appetite for iron ore, joins the growing list of companies competing to feed China's 1.36 billion people. Just last month, Danone paid $550 million for a 25% stake in local baby formula maker Yashili International Holdings (ticker: 1230.HK ).

Investing in baby formula seems like a no-brainer, and not just because there are so many mouths in China to feed. Rising Chinese incomes have pushed up demand for a more protein-rich diet. But population expansion, rising costs and pollution have hurt China's ability to produce enough food at home. A series of food safety scares have undermined public trust in the domestic food supply.

And who are China's most finicky, most pampered bunch of diners? Babies.

Investors not in a position to buy their own dairy farm may want, instead, to consider incumbent players like Fonterra (FCG.NZ), the listed New Zealand dairy cooperative, Hong Kong-listed Natural Dairy (0462.HK) or Australian Dairy Farms (AHF.AU), which went public last month after raising AUD9.3 million in a backdoor listing.

Some might worry that Rinehart is investing in a sector already suffering from oversupply. Prices for milk have been falling since early this year -- not for the fresh stuff, but for the powdered milk that can be shipped abroad without curdling. Supplies finally caught up to the boom in China's demand. And when prices started falling, Chinese importers stocked up, so imports have been falling for the past three months.

And while China earlier this year said it would relax its one-child policy, it won't be enough to reverse the broader decline in potential milk moustaches. The United Nations projects its population of infants and toddlers will begin declining in 2016. If China's mothers -- less than a third of whom breastfeed - rediscover the superiority of their own milk, the market could shrink even faster.

But Rinehart's connections with state-owned Sinomach may help her crack a market now dominated by Nestle (NESN.VX), Mead Johnson (MJN) and local producers like Beingmate Baby & Child Food (002570.SZ) and Biostime International Holdings (1112.HK).

Her deal also comes on the eve of a free trade agreement that China and Australia could sign as early as today. New Zealand's trade pact with China resulted in a 17-fold increase in its milk powder exports to China.

China is meanwhile cracking down on local milk producers, refusing to renew licenses of those that aren't up to snuff, thus winnowing domestic competition. Regulatory changes could also open new opportunities for offshore baby formula. Earlier this year, China's Food and Drug Administration began allowing local formula plants to use imported milk powder.

Two more new rules argue in favor of building a Chinese-run plant abroad: China's formula plants are no longer allowed to import large bags of formula powder and re-package them into smaller bags. And imported formula must be labeled in Chinese. By some estimates, baby formula imports will double in the next few years.

These days more of China's seniors are using milk powder to supplement their diets and their population won't peak until 2049. Nestle earlier this year identified its nutritional milk powder for seniors, Yiyang Protein Powder, as one of its top performers in China.

Milk is also a key ingredient in a range of increasingly popular products in China, from yogurt to chocolate to mocha frappuccinos. The U.S. Dept. of Agriculture estimates China's milk imports will grow from 30% of its total consumption to 42% this year.

And China isn't the only country likely to need more imported milk. The world's biggest milk producer is also the world's second most populous nation, India. Rising incomes and growing demand there have created the potential for a milk shortage.


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